Banks' victory on liquidity will still cost them dear

LONDON Jan 7 What first appears as a victory
for banks in their battle to dilute draconian rules on liquidity
will still mean they have to find trillions of dollars to
protect themselves against their funds running out.

Heavy lobbying by banks over the past two years has bought
them time but they will still have to lock up big new cash
buffers globally from 2015.

The Basel Committee of banking supervisors, representing
most of the world's capital markets, surprised banks on Sunday
with concessions on a planned new liquidity rule so they can
withstand market squeezes.

Banks and some regulators said the original draft, the first
of its kind, was too draconian, tying up vast pools of liquidity
at a time when credit is needed to aid struggling economies.

Most analysts saw the changes as a reflection of economic
reality though one former Fed official said delaying and
diluting the rule will increase risks from banks.

"Per usual, it will be the taxpayers picking up the tab when
a wrong-way bet by a 'too big to fail' bank turns sour," said
Cornelius Hurley, a director at Boston University's centre for
finance and former counsel to the Fed.

Basel is giving banks an extra four years to comply with the
rule by 2019 and include a wider range of risky assets in the
buffer but Bank of England Governor Mervyn King said on Sunday a
strong disincentive will be built into the changes.

Banks will have to set aside more capital if they choose to
pad out their liquidity buffer with the riskier assets such as
bonds backed by home loans, or shares.

The rule was first drafted amid a mood of public anger when
taxpayers were forced to shore up banks in response to the
financial crisis of 2007-2009.

Economists had also expected growth to rebound by now so
banks would find the cash and capital needed to comply with new
rules. But they and the regulators did not expect a massive euro
zone debt crisis that also cast doubt on the solidity of
government bonds.

"The draft rule was written in the immediate aftermath of a
crisis when there can always be a risk of regulatory overshoot,"
said David Green, a former Bank of England and UK Financial
Services Authority official.

"As circumstances surrounding you change, such as the
increasingly visible consequences of constraints on private
sector growth or risks related to sovereign debt, then you would
be wrong not to adjust," Green said.

The liquidity rule is experimental in some ways, seeking to
plug a gap that left banks such as Northern Rock in Britain with
too little cash as a result of the credit crunch that emerged in
2007, forcing taxpayers to foot the bill.

It is part of the Basel III framework approved by world
leaders in 2010 that also forces banks from this month to hold
up to three times more basic capital than before the crisis.

Only 11 of the G20 countries met this month's deadline for
implementing Basel III, with the United States and European
Union failing to get their rules in place.

Negotiations on an EU law to implement Basel III resume on
Thursday and some lawmakers want to dilute the liquidity rule
further than Basel has done by allowing banks to include any
asset central banks accept as collateral.

Sharon Bowles, the UK Liberal Democrat chair of the European
Parliament's economic affairs committee, welcomed a wider range
of assets in the buffer - up to a point.

"With regard to assets that qualify as central bank eligible
assets it would clearly be wrong to frame that so widely that we
ended up with 'anything goes' under emergency or special
treatment rules," Bowles said.

MARKETS GET THEIR WAY

The G20 and Basel Committee have no powers to enforce
regulatory rules beyond public naming and shaming.

G20 regulation has faced setbacks elsewhere too with the
starting date for reforms to make derivatives markets safer
passing in December with few changes in force.

There is still no cross-border system for winding down an
international bank like Lehman Brothers without taxpayer aid,
another core G20 aim of several years standing.

But analysts question whether the delays and concessions
matter that much as investors become pickier and financial firms
move early to exploit tougher derivatives rules.

Banks lobbied hard against the Basel rules that will force
them to hold more capital, up to 9.5 percent in the core
mandatory buffers for the world's top 28 lenders by 2019.

But market and supervisory pressure has meant that most big
banks meet or exceed the Basel levels they must reach by 2019.

"It will be the same for liquidity and banks will want to be
able to advertise that they are stronger than the regulators
need them to be, which leaves those who can't looking like the
weaker brethren," said Graham Bishop, a former banker who
advises the EU on regulation.

A European regulatory source welcomed Basel's more holistic
approach to the liquidity rule given that banks must comply with
many other costly rules as well.

"We really need to assess the global constraints related to
all the new requirements before adding any layer on top and
until now, that was done segment by segment in a piecemeal
manner," the regulatory source said.

There is also a worry among regulators, learning on the hoof
with new types of rules, that piling many rules on banks too
quickly could push risky activities into the hands of "shadow
banks" which have yet to be supervised properly.

"You can see all this as a matter of judgement and testing
of a new rule as you go along," Green said.

Rethinking the liquidity rule may not be the last time that
regulators will have to make concessions.

A raft of changes to make derivatives safer relies heavily
on there being several trillion dollars of extra top quality
collateral to back trades, a quantity experts say is simply not
readily available.

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